The Shadow Economy and Banks’ Lending Technology

Is there a relationship between bank monitoring models and the level of shadow economy? This paper develops a model of optimal lending technology to study the relationship between local underground economic activity and banks' lending choices. In turn, as the aggregate level of informality and tax evasion increase, it becomes more profitable for banks to screen and supervise borrowers using more costly in-depth monitoring technologies. A large dataset of regional Italian data confirms these conjectures